The deficit debate

Every economic drama in Washington features a stock character or two. The budget debate of summer 2003 brings back a familiar one: the deficit hypocrite.

I am speaking of that person whose motive appears to be virtuous parsimony but is in fact base politics. If I sound cynical, consider how the summer has gone. The Office of Management and Budget releases its July mid-session review of the US household. The deficits for this year and 2004 will be 4.2 per cent of gross domestic product, wider than earlier estimates.

What is next? National alarm. Citizens pronounce themselves disturbed - especially the oldest ones, who know the value of pinching a penny. Lawmakers rush to plan corrective legislation. Democratic presidential hopefuls foam at the mouth.

Finally, a domestic issue to batter the incumbent with. Senator Joe Lieberman, Democratic frontrunner, announces that the Bush administration has situated American families so that they are "swimming against a current of red ink". Another candidate, Senator Bob Graham of Florida, says that "it is inconceivable that in just two years, President George W. Bush has taken the nation from historic budget surpluses to the deepest deficits in history".

To close the deficit gap, all these souls argue, the nation needs tax increases. Mr Graham wants both to raise income tax rates and create a new "millionaire's" tax bracket of 40 per cent (higher than anything since the 1980s). Another presidential hopeful, Howard Dean of Vermont, wants to reverse all three of the Bush tax cuts. Senator Olympia Snowe, a Republican from Maine, advocates increasing customs user fees to offset the deficit.

The first part of this argument is correct. The deficit is wider than it has been for a while. Even discounting for the uncertainty following September 11 2001 and for the Iraq war, both parties in Washington have been bingeing. And it is true that in the short term Mr Bush's tax cuts, all three rounds of them, have caused a quarter of the deficit increase.

But in the same weeks the same people who are fussing about the 2003 deficit are talking in a different tone about the other big issue before Congress: the future of Medicare, the health programme for the elderly. As it happens, Medicare and Social Security, America's public pension programme, have enormous unfunded obligations in the hundreds of billions. The scale of these obligations does not show up in a snapshot like an annual deficit number. What is more, a good share of these programmes is officially "off budget" - their debts are missing from a number of other government figures. The off-budget system is in itself a form of institutionalised hypocrisy.

Medicare spending as a share of GDP will almost quadruple in coming generations, moving to 9 per cent of GDP in 2075 from 2.5 per cent currently. In short, these entitlements are programmed to become a problem so enormous that they will make the wartime recession deficit of 2003 seem a tiny pimple. Like France, Germany and Italy, the US will need to reform and cut entitlements. To expand them would be budget insanity.

Yet Medicare expansion is, of course, exactly what many American voters, lawmakers and presidential candidates are fighting for. The goal is to widen the programme to cover prescription drugs for all pensioners. The Senate version of the legislation would increase the overall public debt by 40 per cent over the long term, according to Tom Saving, a Medicare trustee. The Congressional Budget Office has estimated that the Senate version of the bill would yield a law that costs the Treasury $400bn over 10 years. That is greater than the cost of the tax cut passed this spring.

And where are the solicitous defenders of budgetary virtue on Medicare expansion? All for it. Mr Lieberman voted along with a majority in the Senate for the drug benefit. Mr Graham is campaigning for a drug plan for the elderly that is "affordable, comprehensive and universal" - an impossibility. Most hypocritical of all are the judicious elderly. Their greedy lobby, AARP, is insisting on a drug benefit that is even more costly than what Congress plans.

You could argue that Mr Bush is two-faced, having talked surpluses and delivered deficits via costly tax cuts. But this view neglects the truth that a revenue shortfall generated by a public-sector entitlement, such as Medicare, is worse than one generated by a tax cut. An expansion of the public sector cannot contribute to longer-term growth the way a tax cut can. The latter allows the private sector to keep its money and grow, thereby reducing the deficit.

Now the politics. The Democrats are pushing drug benefits to win votes; they also want to reverse tax cuts to take away votes from the Republicans. The Republicans said all along that they would cut taxes and are doing it. They are also betraying their own small government culture to go along with Medicare expansion. This, they posit, will enable them to steal thunder from the Democrats so they can win in 2004 and then, perhaps, save the free world via more tax cuts and entitlement reform. The latter formula has the better chance of reducing budget problems. Pick your hypocrite.

© Copyright 2003 Financial Times

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